Mumbai: Indian equities and the rupee recorded their biggest drop in at least two years on Thursday, a day after the US house of representatives blocked a Bill to fund government spending and the Federal Open Market Committee (FOMC) noted “significant downside risks" to the world’s largest economy, “including strains in global financial markets".

Signs of a slowdown in China and Germany also exacerbated worries about a global recession, prompting investors across the world to pull out money from riskier assets.

The benchmark 30-share BSE index, the Sensex, fell 704 points, or 4.13%, to end at 16,361.15 points.

The broad-based 50-share Nifty of the National Stock Exchange (NSE) lost 209.60 points, or 4.08%, to close at 4,923.65 points. Dow Jones Industrial Average futures traded on NSE ended at 10,850 points, down 527.50 points, or 4.6%.

Investor wealth to the tune of 2.15 trillion was wiped out on Thursday. Experts don’t see any respite in sight for the markets in the near term. They expect stocks to fall further as interim rallies fail to sustain at higher levels.

Also See | Sensex fall (PDF)

Gold, historically regarded a safe haven in uncertain times, was trading 2.38% down on the FTSE at $1,739.93 (Rs 85,260) an ounce (28.35g) at the time of filing this report.

“When such fear psychosis grips the world, the only place where people keep the money is under their pillows. Leveraged players are getting out of the market, while those who hold physical gold continue to hold on," said Vijay L. Bhambwani, a technical analyst.

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The US market opened weak, with the Dow Jones Industrial Average down 3% at 11am local time, having slumped 2.5% on Wednesday.

The sell-off picked up pace after European stocks tumbled nearly 4%, with export-driven software services firms such as Infosys Ltd, energy firm Reliance Industries Ltd and banks among the big losers.

“We are mimicking what is happening globally. Our markets will remain weak unless there is some recovery (in Europe)," said Sailav Kaji, director of institutional equities at Padmakshi Financial Services.

“It’s the currency factor that has pulled the (Indian) markets down. As the rupee falls sharply, dollar holdings of investors are going down. There is a case of liquidation of Indian holdings by institutional investors," said Manish Sonthalia, vice-president and fund manager at Motilal Oswal Asset Management Co. Ltd. “As the QE3 transformed into ‘Operation Twist’, there was an offloading of risky assets across emerging markets," he said, referring to the absence of a third round of quantitative easing and the plan to lower long-term borrowing costs and give a boost to mortgage refinancing, and consumer and business borrowing, referred to as “Operation Twist" after a similar exercise in the 1960s.

“The situation has got complicated by the fact that rupee has depreciated," said Nandkumar Surti, chief investment officer at JPMorgan Asset Management in Mumbai. “Ideally, I would say, the inflation has topped out and we’re at the end of the monetary tightening, but the rupee depreciation has changed the scenario somehow."

Late on Wednesday, the US Federal Reserve announced its plan to purchase by June 2012 treasury securities to the tune of $400 billion with remaining maturities of 6-30 years and to sell, over the same period, an equal par value of treasury securities with remaining maturities of three years or less. The move is to bolster the ailing mortgage market.

This, according to experts, signals a longer-than-expected wait for a recovery in the economy. They also see in the FOMC statement on “significant downside risks" to the economic outlook fears of a possible recession in the world’s richest nation.

Following the Fed’s announcement, the benchmark 10-year US treasury bond yields fell to new 60-year lows of 1.8576% from 1.9436%.

Interest rate sensitive sectors such as realty and banking were among the top five losers on BSE as the rupee dropped to a 29-month low of 49.58 against the dollar, stoking fears that the drop in purchasing power of the currency will push up India’s import bill and consequently inflation.

The BSE Realty index (down 5.67%) lost the most among sectoral indices, followed by the metal index (down 4.34%). Metal prices fell globally after an HSBC report on Thursday showed China’s manufacturing sector was slowing.

Meanwhile, the rupee tumbled to a 28-month low against the dollar on Thursday, ending at 49.58 as the US currency’s strength against emerging market currencies and plummeting local equities prompted investors to sell the local currency.

“There is a dollar shortage in the entire world. The rupee has fallen over 10% in a single quarter. So the sectors that may remain insulated would be export-oriented ones. Some feel the currency is still overvalued and there could a further fall," Sonthalia said.

According to provisional data on NSE website, foreign institutional investors (FIIs) sold Indian shares worth 1,305.55 crore on Thursday and domestic institutional investors bought stocks worth 743.47 crore.

“It looks like some short-term FIIs that made some carry-trade investments (borrowing in low-interest rate currencies to invest elsewhere) exited the market as the rupee fell. They watch both the rupee and the stock market and today both were down," said Deepak Jasani, head of retail research at HDFC Securities Ltd. “The near-term outlook for the markets is sideways with a downward bias."

According to brokerage firms and analysts, the Nifty could drop below 4,500 levels. A Nirmal Bang Securities report said if the Nifty breaks below 4,850-4,800 levels, it may touch 4,400 levels.

Bhambwani sees this as a fair possibility. “The markets will be weak tomorrow also, but you’ll see some short-covering, which will cushion the fall. Tomorrow, we could possibly see the Nifty around 4,850 levels while there is resistance at 4,975," he said.

India’s key indices, the Nifty and the Sensex, have lost 19.74% and 20.22%, respectively, in the year so far and are the worst performers among major Asia-Pacific indices, according to Bloomberg data.

India’s economy will expand 7.8% this year, the International Monetary Fund (IMF) said in its World Economic Outlook on 20 September, slower than the 8.2% estimated in June.

“IMF’s trimming of its growth forecast for India sounds a warning signal," said Amit Chheda, head of equity at Inventure Growth and Securities. “It will make global investors trim their expectations. Measures announced in the last few months in the US have created a psychological impact rather than resulting in concrete changes in economic performance."

Overseas investors withdrew a net $2.4 billion in August from Indian equities, the most since October 2008, according to data on the website of the market regulator. Since January, FIIs have bought Indian stocks worth $539 million till Wednesday, net of selling.

Graphic by Ahmed Raza Khan/Mint

Bloomberg and Reuters contributed to this story.